Dominion Resources (NYSE: D) has joined the rush to export liquefied natural gas (LNG) from US shores via a planned terminal on the Chesapeake Bay.

And while environmental activists accuse the company of failing to adequately disclose the risk that they will manage to block the project, such claims are unlikely to deter investors from piling into a public offering intended to raise capital for the project.

Now let’s back up a bit for some relevant background. Companies wishing to export LNG to countries that lack a Free Trade Agreement (FTA) with the US require approval from both the Federal Energy Regulatory Commission (FERC) and the US Department of Energy (DOE). The non-FTA designation is important, because it covers many of the most lucrative LNG markets, such as southeast Asia.

The licensing process and the cost of obtaining FERC approval are more onerous than is the DOE approval process, so if you want to gauge which export terminals are most likely to actually be built, the FERC approval process is the one to watch.

In 2012, Cheniere Energy (NYSE: LNG) became the first (and still the only) company to win approval from FERC, although the agency is considering another 13 applications with a total potential export volume of just over 14 billion cubic feet per day (Bcfd). For perspective, this is approximately 21 percent of the total US natural gas production volume of 65.7 Bcfd in 2012.

One of those 13 applicants is Dominion Resources, the $40 billion mid-Atlantic utility. Last fall Dominion became the fourth company to win approval from the DOE for a non-FTA LNG export license, for its Dominion Cove Point terminal on Maryland’s Chesapeake Bay. The proposed export volume from this facility is 0.82 Bcfd, and the project cost is estimated at $3.8 billion.

Dominion previously announced that it intends to unlock additional shareholder value by dropping down assets into an MLP. There is precedent for such a move. In 2007 Cheniere created the Cheniere Energy Partners (NYSE: CQP) master limited partnership to own assets such as its Sabine Pass LNG export terminal under construction on the Louisiana/Texas border, as well as another LNG terminal in Corpus Christi, Texas.

On March 31 Dominion filed a Form S-1 with the US Securities and Exchange Commission (SEC) regarding its proposed initial public offering of common units in Dominion Midstream Partners, which would trade on the New York Stock Exchange under the ticker DM. The planned $400 million IPO will consist of all of the outstanding preferred equity interests in Dominion Cove Point LNG. However, the securities filing notes that over time the partnership expects its relationship with Dominion — which has substantial additional midstream assets — will allow the MLP to “grow a portfolio of natural gas terminalling, processing, storage, transportation and related assets.”

The S-1 further notes that 100 percent of the available capacity of the facility is contracted with two parties: (1) a joint venture between Sumitomo and Tokyo Gas and (2) a subsidiary of GAIL (India) Limited. Both contracts are long-term fixed reservation fee agreements with a 20-year term commencing on the date the project is placed in service

My colleague Richard Stavros at the Utility Forecaster provided an analysis of this IPO from the perspective of the parent company in Valuing Dominion After Its MLP IPO. Richard notes that Dominion trades at a significant premium to peer utilities when using the standard enterprise value to EBITDA (EV/EBITDA) valuation measure, but at a discount to leading MLPs. He explores the likely value of Dominion Resources in light of this IPO and the anticipated future asset dropdowns.

On the basis of the existing long-term contracts for all of the regasification and storage capacity of the Cove Point LNG Facility and the belief that the project will commence operations in 2017, Dominion Midstream Partners expects to begin paying cash distributions in late 2017. The sole cash flow generating asset will be the preferred equity interest, which is entitled to the first $50 million of annual cash distributions made by Cove Point.

While Cheniere Energy Partners has paid a distribution since inception despite the fact that it doesn’t expect to begin exporting LNG until late next year, Dominion Midstream Partners is taking a different approach. Cove Point is prohibited from making a distribution on its common equity interests until it has a reserve sufficient to pay two quarters of distributions. That reserve is expected to be in place by the end of 2016.

The major remaining obstacles are the FERC approval and the coalition of environmental and shareholder groups attempting to block the project. The groups recently filed a complaint with the SEC charging that Dominion hasn’t adequately disclosed project risks to investors. One of the risks they cited was one they themselves will attempt to impose, namely “permitting and litigation delay risks.”

In fact, Mike Tidwell, director of the Chesapeake Climate Action Network — one of the groups behind the SEC complaint — explicitly stated that the coalition may mount a court challenge if the project receives the expected approvals from state and federal agencies. (In addition to the FERC approval, Dominion also needs state approval from the Maryland Public Service Commission before beginning construction.)

As early as late next year we should begin to see the first wave of a potential flood of LNG exports. Cheniere Energy Partners will be the first to begin shipping, but Dominion should be among the groups that will likely begin shipping within three years of Cheniere’s start up. Judging from the success of Cheniere Energy Partners — whose unit price has more than quadrupled on top of a distribution that currently yields 5.2 percent — demand for units of Dominion Midstream Partners is likely to be strong.

Nevertheless, I would advise more conservative investors to exercise great caution toward this IPO, given the remaining regulatory hurdles and what promise to be vigorous legal challenges. Rising natural gas prices may pose a challenge for competing LNG export projects, but given that Dominion has already signed up long-term agreements this won’t be a significant risk. Ultimately I predict that the project will go through, but unitholders can expect a bumpy ride.     

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Saying Goodbye to OCI

It’s never a good sign when revenue drops while costs rise. It’s even less of a good sign when revenue drops, in part, because of an employee error that cuts power to your only plant for a significant stretch.

When we recommended OCI Partners in the Aggressive Portfolio three months ago we knew it was a new partnership facing significant commodity price risks and growing competition. Since then, following unplanned downtime in both January and February, it has also become apparent that the operation is not a tight ship.

That’s just too many negatives to overlook now that the partnership’s variable and reduced distribution doesn’t even annualize to a double-digit yield. We no longer have confidence in OCIP’s ability to hit the lower end of its prior distribution guidance of $2 to $2.20 per unit for 2014, as it insists it will, nor in the longer-term outlook.

Although capacity will increase following a plant expansion project that will require another protracted shutdown late this year, the partnership will face increasing competition in domestic methanol production even as the slowdown in China has already moderated growth in global demand, with prices down notably from the winter’s record levels this spring. OCI Partners likely also didn’t see the last spike in natural gas costs in the most recent quarter.

Sometimes admitting error and taking an early loss is for the best. Sell OCIP. 

— Igor Greenwald